NMHC Special Report: Finding Value in Value-Add

Many industry insiders are reconsidering their growth strategies after rents decelerated throughout 2016, interest rates jumped following the presidential election and construction costs continue to rise.

San Diego—Following years of unexpectedly large growth, the multifamily industry showed signs of cooling in 2016. Rents decelerated, interest rates jumped following the presidential election and construction costs increased, leading many multifamily insiders to reconsider their growth strategies as the current cycle progresses.

As top multifamily professionals shared their insights in San Diego at the annual NMHC Apartment Strategies Outlook conference, one of the main strategies offered was to consider value-add investments in specific growth markets.

Construction costs rise

The image of amenity-laden multifamily communities often brings to mind a brand-new urban high rise, but as construction costs continue to accelerate, developers and investors are looking elsewhere to meet their residents’ needs. Enter value-add: Rather than take new projects out of the ground in areas with high land and development costs, firms are targeting class B and C assets that can be remodeled with upgrades such as new countertops, windows and a redesigned gym or meeting space.

Sustainability initiatives are another way developers and owners are driving value-added rent growth. Millennials value environmental stewardship more than any other generation, and are interested in living in sustainable communities despite the potential increase in rent cost. Enhancing the energy efficiency of appliances and fixtures is a relatively quick update that can drive demand for older properties and offset other costs.

Demand is high and not going anywhere

Despite the cycle-high supply, demand for multifamily remains elevated throughout most of the country. While a handful of markets may experience some softness due to recent oversupply, the majority of the country has outsized demand for housing. In years past, some of the housing demand was addressed by building single-family homes, however single-family home construction is not keeping pace this cycle.

Without the single-family stock, renters continue to turn to apartments for their housing needs, and it’s not just Millennials who are choosing multifamily. Baby Boomers and Generation Y are choosing location and lifestyle over suburban size and space, drawn by easy access to work and play options and the new amenities available in the apartment market. As urbanization continues, renters are expected to actively pursue remodeled and updated units.

Uncertainty looms

While optimism was apparent throughout the NMHC conference, uncertainty also emerged as the biggest threat facing today’s market. The extended recovery and the unclear results of the new administration and Congress have left many in the multifamily industry hesitant to develop new properties. Access to capital has tightened as interest rates rise and firms take conservative approaches when underwriting rent growth.

Value-add renovations offer a strong alternative to new development, as the projects are less labor- and cost-intensive, but can provide competitive market rate rents as a result. Market and submarket selection remains crucial, as external factors will also impact the success of a value-add initiative.

With homeownership at recent lows, increasing interest in urban and near-urban living, and the current cycle’s uncertain lifespan, value-add investments prove to be a viable strategy for developers and owners in today’s multifamily market.